A CASE FOR AUTOMATIC HAIRCUTS TO

DEFERRED PARTNER COMPENSATION

“…Managing Partners say theirs is an impossible task because

of the independent nature of the “prima donnas’ they are

supposed to lead.”

— David Maister

It has often been said that leading a CPA firm is analogous to herding cats — impossible to do and yet try we must!

There is no doubt about it. Leading and governing partners in small and mid-sized CPA firms, at times, can be very daunting tasks for Managing Partners.

While there are many aspects of leading and governing a CPA firm, this Perspective focuses on the provisions in a firm’s Partnership Agreement that de

al with partner responsibilities leading up to retirement and firm responsibilities post partner retirement.

To be perfectly clear, we have found that most partners in small and mid-sized CPA firms fully respect and comply with the provisions in their Partnership Agreement. Unfortunately, we have also found that almost every firm has a number of partners (usually high performing partners who, while high performing, are also high maintenance partners) who either interpret Partnership Agreement provisions in a way that benefits them in some way or, worse yet, choose to ignore these provisions all together. As a result, it takes a strong-willed Managing Partner to enforce many aspects of the Partnership Agreement. If the Managing Partner isn’t strong-willed, the high performing/high maintenance partners will certainly push back and that’s when some ugly discussions inevitably take place.

Our particular focus is on three inter-related Partnership Agreement provisions that often create conflict between the management of the firm and certain partners. They are summarized below:

Partners must give the firm two years notice before his/hers contemplated retirement date. This is usually baked into a Partnership Agreement to allow the firm adequate time to transfer client relationships to succeeding partners.

During the two-year retirement notice period, partners have the responsibility to transfer client and referral relationships to new client service partners – most of the time to younger partners who need to build a client list.

The firm provides deferred partner compensation arrangements that have been earned because partners were good soldiers over many years of service. To some degree, earning that deferred compensation comes when partners provide timely notice of retirement (particularly important when a partner chooses to retire before the mandatory retirement age) and the timely transition of client relationships to the next generation. If you, however, ask those high performing/high maintenance partners about deferred compensation arrangements, they will say that these payments are entitlements and the partners are due whatever the Partnership Agreement calls for. No ifs, ands or buts!

Therein lies the rub. Individual partner motives get questioned when retirement notice isn’t timely provided or, when once noticed, client and referral relationships aren’t transitioned in a timely manner. In these circumstances, firms get squeezed into action and, as a result, clients aren’t always successfully retained and transferred to the next generation post retirement. Is this what the noncompliant partner wanted to happen in the first place? Did the noncompliant partner want to hold onto to the client and referral relationships so they can be moved to a new employer if the partner decides that the grass is greener at another firm?

Isn’t insanity defined as doing the same thing over and over again and expecting a different result?

Of course it is but yet, while puzzling to us, we find that this scenario repeats itself over and over again at many small and mid-sized CPA firms and nothing much is done to deal with the management challenge. We find that leaders at many firms are not strong willed in enforcing the provisions of their Partnership Agreement. It is almost as iManaging Partners throw up their hands and fall into the trap that losing clients and referral sources is inevitable as partners retire. While some clients might find that they want to seek a new firm when their client service partner retires, there are things that can be done to avoid the loss of many.

In Our Opinion, firms should implement a process to reduce the likelihood of nonadherence to these provisions in the Partnership Agreement and if all else fails, we also suggest that Partnership Agreements be amended to include “enforcement teeth” or “penalties” to these provisions.

Here is what we suggest:

We are strong proponents that every Managing Partner (or members of the Executive Committee) meet quarterly with their partners to review progress towards goals established at the beginning of each year. For partners who are 55 years of age or older, the initial meeting should include a reminder that proper notice is due the firm within two years of retirement, the establishment of a planned timeline for transferring client and referral relationships to the next generation and, last but certainly not least, a discussion about setting expectations for the retiring partner that he/she will receive reduced compensation when compared to the peak years as their individual contribution to firm profits will be reduced during the final two years of employment.

At each subsequent quarterly meeting with the retiring partner, a discussion involving progress in transferring client and referral relationships in accordance with plan should be had. If these relationship transfers are being made in accordance with plan, that is great. If, on the other hand, client and referral relationship transfers are not being made in accordance with plan, the partner should be reminded of his/her responsibilities. Hopefully this gentle reminder will create sufficient activity and relationship transfers begin to get back to plan.

The Partnership Agreement should be amended to include language that clearly stipulates that noncompliance with timely retirement notice and failure to timely transition client and referral relationships in accordance with an agreed-upon timeline can result in two annual automatic reductions (or “haircuts”) to otherwise earned deferred compensation of up to 5% each. The discretion to exercise this provision is in the hands of the firm’s Executive Committee. A reduction of up to 10% of a deferred compensation amount is not chopped liver and hits a noncompliant partner right in the wallet where it really hurts. This deterrent, when all else fails, usually cures much of the nonadherence.

IN CONCLUSION

Remember the old TV commercial by Smith Barney “we make money the old fashioned way… we earn it”? Well, the same is true with deferred partner compensation. It is earned. It is not an entitlement. We strongly believe that if a retiring partner doesn’t adhere to the provisions of a Partnership Agreement (when it comes to providing retirement notice and transfer of client and referral relationships), that partner hasn’t, at least in part, earned it. If not earned, the firm’s Executive Committee should be able to exercise its discretion in giving a “haircut” to the deferred compensation payments. To avoid such an ugly occurrence, there is a process that can be put in place which usually creates an environment of better partner compliance.

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Dom Esposito, CPA, is the CEO of ESPOSITO CEO2CEO, LLC — a boutique advisory firm consulting to leading CPA and other professional services firms on strategy, succession planning and mergers, acquisitions and integration. Dom, voted as one of the most influential people in the profession for two consecutive years by Accounting Today, authored a book, published by www.CPATrendlines.com., entitled “8 Steps to Great” which is a primer for CEOs, managing partners and other senior partners. In Our Opinion, is a continuing series of perspectives for leading CPA firms where Dom and his colleagues share insights, experiences and wisdom with firm leaders who want to “run with the big dogs” and develop their firms into sustainable brands. Dom welcomes questions and can be contacted at either desposito@espositoceo2ceo.com or 203.292.3277.